Interest Rate Spread, Liduidity Creation, Firm Characteristics and Performance of Commercial Banks in Kenya

Abstract

The performance of any bank is majorly influenced by its ability for liquidity creation to meet customer needs while remaining afloat. A key consideration is how well the interest rate spread is controlled to boost deposits as withdrawals are managed. However, this ability may be affected positively or negatively by the bank’s characteristics, such as age, size, ownership, and other internal firm characteristics. The banking industry in Kenya has undergone several handles in their liquidity creation activities which directly influence their earnings.This has seen a few of the banks such as Imperial and Chase banks placed under receivership.However, the regulator has been scanty with detailed informationas to the main challenges facing the industry and the longterm solution to curb such occurences. Thus, it is crucial that the investor hires competent managers with the expectation that they will innovate to sustain and grow the business leading to high performance. This thus, has led to this study with a general objective to evaluate the relationship among interest rate spread, liquidity creation, firm characteristics and performance of commercial banks in Kenya. Moreover, it specifically sought to examine the intervening influence of liquidity creation and moderating influence of firm characteristics on the association between interest rate spread and firm performance. Corresponding null hypotheses were formulated in line with each of these objectives. The study was anchored on liquidity preference theory and used positivistic philosophy with an epistemological element in testing the four quantitative hypotheses. The study relied on balanced panel data where secondary data was collected from financial institutions in Kenya for a ten-year period from 2008-2018. The study used a descriptive research design and was subjected to random effects panel regression analysis. Hypotheses were tested at 95 percent confidence levels (p<0.050) to determine the effect of the independent variable, moderating variable and intervening variable on the performance of the banks which was the dependent variable. The results indicated that interest rate spread as an independent variable, was significant in determining the performance of the banks. The study also established that liquidity creation was a non-intervening variable in the relationship between interest rate spread and performance. Firm characteristics which included firm size, age and ownership did not exert a moderating effect on the relationship between interest rate spread and performance. Moreover, the results revealed a significant joint effect of interest rate spread, liquidity creation and the firm characteristics on performance. The results of this study add to existing practice and knowledge by using liquidity creation as an alternative metric for performance measurement, which the banks can utilize to remain afloat by meeting their immediate monetary demands for their external clients and their internal daily financial requirements. The policy makers and regulators in reviewing liquidity creation capacity shall take action on viability of undertaken projects based on the risk appetite exposure in consideration of the contagion effect of bank failures. Maintaining a narrowed spread in interest rates is also crucial in maintaining a competitive edge in an increasingly competitive financial market. The study also contributes to improving the existing literature and body of information in determining the predictors of firm performance in Kenya. It provides evidence against firm characteristics as unreliable predictors. Future research on other factors that influence the firm's performance is recommended to enrich the literature more in this area.